A company can change its shareholdings by issuing new shares or a shareholder selling their shares. Common reasons why companies change their shareholding include:
- the company bringing on new financial investors;
- the company issuing shares to a key employee;
- a shareholder leaving the business and wants to, or has to, sell their shares to other shareholders; or
- a shareholder wanting to sell their shares to a third party to free up some cash.
A company must take different actions to achieve these outcomes. Points 1 and 2 relate to a company issuing new shares while points 3 and 4 relate to a shareholder selling their shares.
|Share Transfer||One shareholder sells their shares to another party. The other party will pay the shareholder the purchase price as they own the shares.|
|Share Issue||The directors (and/or shareholders) decide to create new shares in the company and give them to a new or existing shareholder. The incoming shareholder will pay the company the purchase price.|
We set out the steps involved in a share transfer and share issue as well as what this difference means for startup founders looking to bring on an investor.
What is a Share Transfer?
Shares can be transferred to existing or new shareholders, for instance, an investor, employee or adviser. The transfer can take place without payment or as part of a share sale. But you should know that transferring shares may have tax implications for the seller or purchaser. If you have any questions, speak to a tax advisor. The steps involved in a share transfer are as follows.
1. Do You Have Permission to Transfer the Shares?
Before signing the share transfer document, you will need to confirm that you have complied with any requirements set out in the company’s shareholders agreement and constitution as well as the Corporations Act 2001 (Cth) (Corporations Act). For example:
- Are you required to offer the shares to existing shareholders first?
- Do you need the consent of the other shareholders? (e.g. if the new shareholder is a competitor or foreign entity)?
- Do you need the consent of the board of directors?
The company constitution or shareholders agreement will set out whether you require the following to approve the transfer:
- consent of the shareholders or waiver of pre-emption rights; and
- resolution of the board of directors; and
- independent valuation of the company.
2. Do You Have the Documents in Place for the Sale?
Once you have complied with any requirements set out in the company documents and Corporations Act, you are required to complete a share transfer form. This is a one-page document outlining the:
- name of the company;
- jurisdiction (i.e. state) the company is incorporated;
- description of the securities;
- quantity being transferred;
- consideration (i.e. the amount to be paid),
- date of transfer;
- party transferring the shares;
- party receiving the shares;
- way the shares will be held (i.e. beneficially or non-beneficially); and
- acknowledgement and agreement by the person transferring the shares that they will be transferred on the agreed date.
If you are transferring shares to a third party, they may also require a share sale agreement, setting out:
- the mechanics of the sale (e.g. any pre-conditions to the sale);
- when the sale occurs; and
- what each party must do on and after the completion date;
You will also provide the purchaser with detailed representations and warranties about the company and their shares, for instance:
- the shares are fully paid ordinary shares;
- the existing shareholder has full legal and beneficial title to the shares;
- the existing shareholder is entitled to transfer the shares; and
- the shares are not subject to any encumbrances (e.g. a security interest).
3. Have You Lodged the Documents?
Once the purchaser has paid the share price and parties have signed the share transfer form, the form should be lodged with the company. The company then:
- issues a share certificate to the party receiving the shares;
- updates its members’ register to reflect the share transfer; and
- notifies ASIC about the transfer.
What is a Share Issue?
A share issue involves ‘creating’ more shares and distributing them to existing shareholders, incoming investors, key employees or advisers. If the company issues shares for less than fair market value, there may be tax implications for the shareholder. It’s important to speak with a tax advisor beforehand.
1. Have You Complied With Your Company’s Documents?
As with a share transfer, you must confirm that you have complied with the shareholders agreement, company constitution and Corporations Act 2001 (Cth). Depending on the requirements set out in the company documents, you may also need shareholder approvals and a board resolution.
If you don’t have a shareholders agreement, we strongly suggest you speak with a legal adviser and draft one for your company. A shareholders agreement will provide certainty about decision-making powers and sets out:
- who can appoint a director;
- what happens if a majority shareholder wants to sell the whole business; and
- who makes what decisions.
2. Issuing Shares
Depending on your shareholders agreement and company constitution, you must include ‘authority to issue the shares’ in your resolutions. At the very least, the investor should sign a share application form. This is a one-page document under which they agree to be issued with shares and hold the shares subject to the company constitution.
For larger investments, we recommend you enter into a share subscription letter. A sophisticated investor may require a more robust share subscription agreement, setting out:
- the mechanics of the share subscription; and
- detailed representations and warranties about the company and its shares.
The company will also need to:
- issue a share certificate to the incoming shareholder;
- update its member register to reflect the share issuance; and
- notify ASIC of the share issuance.
Why Does this Difference Matter?
Imagine you had a company that had issued 100 ordinary shares, you would own 100% of the shares. If you wanted to bring on an investor who would own 50% of the company, you could either:
- transfer 50% of your shares to the investor (which could have tax consequences); or
- issue the investor 100 shares.
You would still own your 100 shares, but, you would now own 100 of 200 shares. The investor would own the other 100, giving you the 50/50 split you intended. We have set out the shareholding before the investment in the table below.
|Shareholders||Number of Shares Owned||Percentage Held|
After the investment, you would issue 100 shares to the oncoming investor.
|Shareholders||No of Shares Owned||Percentage Held|
Bringing On Investors Through a Share Issue
The number of shares the founder owns hasn’t changed. But what has changed is the percentage of the company the shares represent. Startups typically bring on investors through a share issue because:
- Investors want to receive new shares from the company rather than old shares from existing investors. It’s less likely that the new shares will be subject to any encumbrance.
- Investors will want their investment money to go to the company rather than an existing shareholder. This way, they know the startup is using the money to grow the business and create a return on their investment.
- Investors will likely want to see representations and warranties from the company about the company and shares rather than from an existing shareholder.
- Provided the company is issuing shares for a fair market value, a share issuance is less likely to have tax implications. Again, it’s essential to discuss your particular circumstances with a tax advisor.
If you are looking to give shares to a third party, you can either issue new shares or transfer existing shares. Regardless of which option you choose, you will likely require permission from a number of parties. If you have any questions about what approvals you need or help drafting the necessary documents, get in touch with LegalVision’s commercial lawyers on 1300 544 755.
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